By Natasha Doff
If you thought Ukraine’s five-month debt-restructuring battle with
Franklin Templeton was tough, just wait until the country starts
negotiating with its second-biggest creditor, Russia.
There’s a $3 billion Eurobond due in December that former
President Viktor Yanukovych sold to Russia shortly before his ouster in
February 2014 and Vladimir Putin’s annexation of Crimea a month later.
Paying this
bond in full is "not an option" and Ukraine wants Russia to accept
the same terms as other creditors, Finance Minister Natalie Jaresko said in an
interview conducted hours before the country on Thursday revealed its main
bondholders agreed to a 20 percent principal writedown.
Her peer in
Moscow, Anton Siluanov, swiftly knocked down the offer, saying Russia
won’t take part and will demand Ukraine pay back the entire sum. The country
deems itself an official rather than a commercial creditor, according to the
minister, who added Russia will invest the $3 billion in infrastructure.
Where
negotiations go from here is likely to be guided by the International Monetary
Fund, which has yet to decide how to categorize the bond, and with which
Ukraine is engaged on a $40 billion bailout. The situation is further
complicated by strained diplomatic relations with Russia, which Ukraine accuses
of supporting a smoldering insurgency in its easternmost regions.
Below are
three scenarios Ukraine faces with the bond and the reasons they may or may not
work:
Scenario 1:
Pay Up
Ukraine may
have no choice but to pay the bond in full or risk losing its bailout should
the IMF decide it’s official debt. IMF policy dictates it won’t lend to
countries that are in arrears on such obligations, while missing payments to
private creditors doesn’t exclude it from maintaining a program.
The
preliminary view by staff at the crisis lender is that the bond should be
classified as official debt, a person familiar with the matter told
Bloomberg in June. A final decision will be taken by the IMF’s executive board,
which will discuss the matter only when Ukraine is in arrears to Russia,
according to Nikolay Gueorguiev, the IMF Mission Chief to Ukraine.
The biggest
reason not to take that route might be that handing over such a sum to Russia
would be "politically unacceptable" for Ukrainian President Petro
Poroshenko, according to Christopher Granville, managing director of
research group Trusted Sources in London. The country’s leader is already struggling to win over public
support.
Paying the
bond would also deplete Ukraine’s already scarce international reserves
and put an IMF savings target at risk. The fund has asked Ukraine to make $15.3
billion of savings in public-sector financing in the next four years.
Scenario 2:
Restructure
Ukraine
could pursue restructuring without the risk of losing its bailout if the IMF
decides the bond is private-sector debt.
Even if the
IMF decides it’s official debt, the fund could change its policy on lending
regarding arrears, according to former IMF Executive Board member Douglas
Rediker. The issue was raised in a 2013 paper that
said the IMF was considering extending the policy that allows lending to
governments in arrears to the private sector to include official debt.
The downside
to this scenario is that Russia is unlikely to accept, having repeatedly said
since the beginning of the year that the bond isn’t private debt. The Finance
Ministry in Moscow said in March that while the notes took the form of a tradeable
Eurobond, it wasn’t issued at the same market conditions.
The bond,
which was offered to Ukraine as part of a $15 billion loan after it pulled out
of a trade pact with the European Union, was sold at a 5 percent coupon,
compared with a yield at the time of about 12 percent on 2017 debt. Ukrainian
President Petro Poroshenko has described the bond as a "bribe."
Scenario 3:
Default
Ukraine may
prefer to default if it can be sure the IMF will continue lending. If Ukraine
withheld payment, it would have a 10-day grace period, meaning it would be in
default on Dec. 30. Russia also has the option of demanding early repayment
since Ukraine’s public debt has exceeded 60 percent of gross domestic product,
violating the terms of the loan.
The
potential blowback from such a move includes a Russian lawsuit, something that
Finance Minister Anton Siluanov threatened in June before an interest payment
was made. That would probably lead to a showdown in British courts as the bond
is governed by English law.
Refusal to
pay could also further strain Ukraine’s relations with Russia at a time when it
is trying to maintain a fragile cease-fire in its east and negotiate new
pricing for gas supplies.
For a larger
image of the flowchart below, click here
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